With the economy improving, budget cuts in infrastructure from diminished deficit spending will limit upside in construction firms. In this article, I will run you through my DCF analysis on Deere (DE) and then triangulate the result with an exit multiple calculation and a review of the fundamentals compared to Caterpillar (CAT) and AGCO Corporation (AGCO). While I do not expect the firm to outperform the broader market, I see room for meaningful upside.
First, let's begin with an assumption about revenues. Deere finished FY2011 with $32B in revenue, which represented a 23.1% gain off of the preceding year: Acceleration. Analysts model a 10.8% per annum growth rate over the next half decade, and I think this is reasonable since it is roughly in-line with what is expected for the S&P 500.
Moving into the cost-side of the equation, there are several items to consider: Operating expenses, capital expenditures and taxes. I model cost of goods sold, SG&A, R&D and capex as 70%, 11%, 4% and 3.2% of revenue, respectively. Taxes are estimated at 36% of adjusted EBIT (excluding non-cash depreciation charges).
We then need to subtract out net increases in working capital. I expect this to hover around -3.3% of revenue.
Taking a perpetual growth rate of 2.5% and discounting backwards by a WACC of 11% yields a fair value figure of $92.71, implying 15.4% upside. This WACC is largely due to the high beta of 1.53. The problem with DCF models are that they are, of course, highly sensitive to discount rates. Based on my sensitivity analysis, the standard deviation for various WACCs is $26.41 - nearly a third of the value per share.
All of this falls within the context of strong performance:
"With this morning's first quarter earnings announcement, John Deere has started 2012 on a strong note. Income and sales both reached new records for the first quarter of the year. It was our seventh straight quarterly record. The improvement was broad based. Ag and Turf had another strong quarter and our other division Construction and Forestry and Financial Services contributed as well. Healthy demand for farm machinery continued to play a big role in our results."
From a multiples perspective, Deere trades at a respective 11.9x and 9.4x past and forward earnings versus 14.1x and 9.2x for Caterpillar and 7.9x and 8.9x for AGCO. Assuming a multiple of 11x and a conservative 2013 EPS of $8.43, the rough intrinsic value of the stock is $92.73, virtually in-line with my DCF result.
Consensus estimates for Caterpillar's EPS forecast are that it will grow by 28.5% to $9.51 in 2012 and then by 19% and 17.8% in the following two years. Assuming a multiple of 12.5x and a conservative 2013 EPS of $10.98, the rough intrinsic value of the stock is $137.25, implying 31.6% upside. The company is led by top management and the beta of 1.88 will, in my view, only serve to drive high-risk adjusted returns. It is the leader in its field and thus well positioned to gain share in a weaker infrastructure market.
Consensus estimates for Agco's EPS forecast are that it will grow by 12.9% to $5.06 in 2012 and then by 4.5% and 8.1% in the following two years. Of the 13 revisions to EPS estimates, all but one have gone up for a net change of 1.63%. Assuming a multiple of 11x and a conservative 2013 EPS of $5.21, the rough intrinsic value of the stock is $57.31, implying 22% upside. This is not enough, in my view, to merit calling an investment a "value play." The stock is also around 90% more volatile than the broader market, and the risk is not tilting exactly in its favor given competitive pressures. Accordingly, the Street is only mildly optimistic about the stock and rates it around a "hold" (source: T1 Banker).
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